In May 2010, Brussels could not resolve the euro zone crisis; so it bought time. Now the period of Band-Aids is over and the time has run out.
Since spring 2010, I have argued that orderly and controlled restructuring of the Greek public debt is preferable relative to other options, which will only deepen the problems and extend risks across the euro zone.
As recent developments indicate, Brussels’s unwillingness to face the realities is now part of the problem.
The Greek Tragedy, déjà vu
As more than 21,000 people took part in the demonstrations in Thessaloniki, Greek Deputy Prime Minister and Finance Minister Evangelos Venizelos announced a package of supplementary austerity measures on Sunday, hoping to meet fiscal targets for 2011-2012, in exchange of further foreign aid.
Venizelos announced the new measures under the pressure of EU/IMF lenders ahead of the release of the sixth tranche of the 110-billion euro ($150 billion) bailout pact agreed on May 2010.
Since spring 2010, the Greek government’s political commitment to economic privatizations has been fragile. The austerity programs have not enjoyed the sustained support of the Greeks themselves.
Even as the Greek government announced it will impose a new property tax to cover a €2 billion ($2.7 billion) shortfall in budget targets this year, minister Venizelos warned that the Greek economy would shrink much more sharply than previously anticipated. Instead of 3.8% as forecast in May, the contraction would be 5.3%.
Last week, the high-level representatives of the troika – the EU, ECB and IMF – left Athens in frustration, after deciding that Greece had failed to make progress on two-thirds of the bullet points on the austerity to-do list. The troika sees the deficit at 8.8% this year and is asking Greece to take an additional €1.7 billion of new austerity measures.
Behind the façade, tensions are flaring even in Brussels. An anonymous European Commission source told the Suddeutsche Zeitung that “absent a troika report, we will see a national bankruptcy at the end of the month.”
Without growth, Athens cannot pay its debts; in turn, austerity measures will keep that growth subdued, minimal, or negative.
The restructuring of Greek debt does not necessarily mean an end of European unity; rather, a truly integrated Europe is not possible without restructurings and reforms in Greece and other crisis economies in the euro zone.
Risking the triple-A Europe
Since May 2010, most PIIGS economies – especially Greece, Ireland, Portugal – have struggled to fulfill the conditions of the bailout packages.
These episodes were possible as long as the turmoil was confined to the small mini-euro economies; and as long as the euro zone’s AAA-rated countries were willing to finance what their citizens perceive as fiscal abuse by Southern Europe’s “Club Med” nations.
This phase came to an end with the Finnish election in mid-April, when the Euro-skeptics “Finns Party” quintupled its support and ended up complicating the Greek bailout. At the euro zone level, however, it reflected the ongoing political backlash that is under way in AAA rated countries.
In Germany, Chancellor Angela Merkel’s poll ratings have suffered from the state elections, which have hurt the ruling government coalition, especially as the bill for bailing out deficit-hit states has been mounting. At the end of September, she must push the latest euro rescue plan through the Bundestag, where she faces resistance not just from the opposition but from her own party and coalition.
Concurrently, President Sarkozy’s support has collapsed in France, and he is unlikely to introduce drastic austerity measures ahead of the 2012 elections.
In Italy, Berlusconi’s support has plunged for months, and the government appears to be softening its austerity policies. Rome’s $64.5 billion austerity package requires many belt-tightening measures that were proposed by the Berlusconi government, but quickly discarded in the face of protests.
As the largest AAA-rated economies, the euro zone’s main creditor nations – Germany, France, the Netherlands and Finland – are key to Europe’s bail-out fund; the €440bn European Financial Stability Facility, which is viable only as long as they (and their triple-A rating) stand behind it.
China cannot save Europe; Europe must save itself
Not so long ago, Italy’s finance minister Giulio Tremonti was still penning essays about his fears of China’s “reverse colonization” of Europe; now Italy’s center-right government is turning to cash-rich China hoping that Beijing make “significant” purchases of Italian bonds and investments in strategic companies.
There is great sympathy in China for the euro zone economies. In the long-term, the current euro challenges may even support more extensive Euro-Chinese trade and investment, which can boost economies in the West and the East.
However, Chinese people are Beijing’s first priority. China’s current financial position is relatively strong, but the GDP per capita of the Chinese is still relatively low relative to European living standards.
As aggregate euro-area debt is moving closer to the 90% level, it weighs heavily on long-term growth prospects; in the absence of growth, sustained recovery is not possible.
With its solvency, liquidity, banking/central bank and competitiveness challenges, the euro zone debt crisis cannot be resolved with piecemeal solutions, or incremental Band-Aid.
The current euro crisis is the result of two to three decades of misguided policies. From the mid-1960s to the mid-1980s, primary spending in major European economies increased quite rapidly, reflecting a surge in health care and pension spending.
The negative effects of the global financial crisis may diminish by the mid-2010s. At the same time, however, euro economies will have to cope with the massive challenge of reducing debt ratios when ageing-related spending – especially pressures from health care systems – will put additional pressure on public finances.
Addressing these fiscal challenges in a comprehensive way requires pro-growth policies, structural reforms, gradual and steady fiscal adjustment, stronger fiscal institutions and adequately equitable burden sharing among the relevant stakeholders.
In reality, the effort by Brussels to mumble through the crisis has effectively mitigated any success in overcoming fiscal challenges.
The futile attempt to treat euro challenges as a liquidity crisis in one country after another has only contributed to the systemic and pervasive solvency crisis.
Europe must stand on its own, or it will fall.